Ripple Explained - Chapter 3: How Ripple works (part 2)

Ripple is both the umbrella term for the peer-to-peer currency transmission platform (RippleNet) and a commonly used term for the digital currency (XRP). The platform itself is an open source protocol, so anyone can download and use it for free. The Ripple software is developed by Ripple's world-class software developers. Ripple monitors and controls the technology while networking with financial institutions and governments worldwide. In theory, everyone can modify the software because it is open source. However, it is practically impossible to introduce changes that are not confirmed by the Ripple software developers. The development of the software is therefore entirely carried out by the company.

Any kind of value can be transferred via RippleNet. XRP can be exchanged for other crypto currencies such as Bitcoin, Ether, Litecoin or fiat currencies. The universality of the protocol even makes it possible to exchange airline bonus miles for Bitcoin. Every network participant can submit bids or offers, and Ripple then routes these requests through the network in such a way that the exchange is as cost-effective as possible.

The basis for this universality are the so-called «gateways». These serve as intermediaries by receiving and transferring currencies via certain addresses on RippleNet. Any company can register and apply for such an address to join the network. Each currency has its own specific gateway. For example, for USD Snapswap and for Bitcoin Bitstamp are used. Ripple can thus be compared to a promissory note or to a bond. The gateway owners (mostly banks) issue units of value based on the Ripple protocol and guarantee their redemption. This process is also referred to as «to ripple», which means «to liquidate the values (USD, EUR, etc.)», i.e. to convert them into XRP. Banks or other financial institutions have access to RippleNet via these gateways. These nodes form Ripple's «digital cash book». Like Bitcoin, XRP also relies on a decentralized system in which all network participants verify transactions. This digital cash book, distributed over the gateways, records every transfer.

As already mentioned, Ripple's transfer network is based on promissory notes (also called IOU, «I owe you») that are exchanged among the participants. These promissory notes store how much and in which currency a participant owes another participant. Banks can issue these promissory notes to each other in large amounts of data within seconds, transparently, almost free of charge and unmanipulable. The IOUs are converted via the gateways into XRP or fiat currencies in order to assign them their real monetary value. These IOUs are also recorded in a register that is updated every few seconds. The Ripple register therefore contains all account balances of the XRPs, as well as protocols for all processes within the RippleNet. The register itself is located in a public database that everyone has access to. Thus, Ripple ensures transparency between network participants.

The transaction processing on the Ripple protocol is based on a consensus algorithm, which is backed by the aforementioned register of account balances. If there is a change in the register - through purchase or sale offers - an agreement is reached within seconds after the change by the network participants regarding the changes in the register and within the framework of the consensus algorithm through the Ripple protocol. This ensures fast and secure transaction processing - without central authority to decide which transactions to confirm and execute. This is why the Ripple platform is also decentralized. Transactions are confirmed in the network by so-called «Trusted Validator Nodes». It is criticized, however, that some Validator Nodes are still operated by the company itself, which rather speaks for centrality. According to Garlinghouse, this will change, because such nodes will be operated by third parties in the near future. The company published a «Strategy for Decentralization» in mid-2017. This includes that Ripple also includes external validators in the «Unique Node Lists» (UNLs), in which the trustworthy nodes are selected, provided that these nodes meet certain requirements defined by Ripple. The goal is to no longer operate a validator at all. Ripple's structure thus makes it possible to increase the number of transactions per second to over 50,000. All you have to do is include more Trusted Validator Nodes.

«With respect to XRP, we are incredibly focused on international payments, I think we are probably the only digital asset that has a clear use case with respect to what we are trying to do with the asset» Miguel Vias, Head of XRP markets

The Ripple Token XRP

XRP itself can also be used on the platform. It is interchangeable with any currency or digital asset. Users pay a small transaction fee of approximately 0.00001 XRP for exchanging XRP. This fee is not retained by Ripple Labs, but «destroyed». This is to protect the system from attacks that attempt to flood the network with millions of transactions and disrupt it. Due to the destruction of XRP tokens and the limitation of XRP units to 100 billion XRP, the currency is deflationary in the long run - unlike Ether, which has (so far) no maximum number of coins in circulation.

However, the usage of XRP is independent of RippleNet. One party does not need XRP to transfer currencies. Therefore, the value of Ripple is not dependent on the XRP token, but is derived from the network itself with the ability to transfer money quickly and globally. XRP can theoretically be exchanged for another coin. However, XRP is currently used in the Ripple network because it is issued by Ripple itself. It is still unclear whether in future XRP would be used as a mediatory currency to transfer money. According to the New York Times, some banks are interested in the technology, but not in the digital currency itself. However, it could also be that banks will create their own bank coins and want to use the Ripple network with their own coin.